Annuities (DP IB Applications & Interpretation (AI)): Revision Note

Annuities

What is an annuity?

• An annuity is a fixed sum of money paid to someone at specified intervals over a fixed period of time

  • Most commonly this will be because of an initial lump sum investment which will be returned at fixed intervals of time with a fixed interest rate

  • Either from personal savings or from receiving an inheritance

How are annuities calculated?

• Your GDC should be used to solve questions involving annuities

  • Use the finance solver mode (sometimes called the TVM (time value of money) solver)

    • N will be the number of payment periods (remember to include months and years if necessary)

    • I (%) is the interest rate

    • PV is the amount that was invested – as this has been invested it will be entered as a negative number

    • PMT is the amount paid per period – as this is being received it will be a positive number

    • FV is the future value (for an annuity this will be zero as the balance at the end of the payment period will be zero)

    • P/Y is the number of payments per year

    • C/Y is the compounding periods per year

    • PMT@ is the time of the year or month the payment is made (usually the start)

  • Leave the section that you need to find out blank and fill in all other sections

  • Your GDC will fill in the last part for you

• Although you are unlikely to need to use it, the formula for calculating an annuity is:

• Where

  • FV is the future value

  • A is the amount invested

  • n is the number of years

  • r% is the interest rate as a decimal (e.g. at 6%, = 0.06)

• This formula is not given in the formula booklet, however your GDC will work out annuities for you so you do not need to remember it